Introduction
This report discusses about the detail of conducting an analysis and calculationof 10 companies’ cost of Equity and the CAPM.The aim of this assignment is to analyze and evaluate the investment effectiveness and measure the return and risk of the investment of the 10 companies. The 10 company’s financial calculation and data sources utilized in this report are in Excel Sheet. Capital asset pricing model (CAPM), cost of capital (K), stock valuation, risk and expected return will be discussed in this report as methods to analyses and evaluate the investment projects. The organizations selected are from S&P 500 index and are shown in the excel sheet with the calculations.
Evaluation and Analysis
Cost of Equity ‘ K’
Cost of Equity which is idenitfying and evaluating the investment needs for various project, securitites , expected returns discount, and calculates the cost of equity.It figures out the expenditure level ( like interests payments, dividends etc.). Also the average capital cost combines the information of the elements formed by capital and evaluates the total capital worth.(Baresa,2013)The formula used for calculating the cost of equity is:
K= (Div/S)+g
Where, K is cost of equity, D is next years dividend, S is stock price current and g is the growth rate.
Capital Asset Pricing Model (CAPM)
“This is the model used for the stocks valuation by the relating return and risk . The investor demands additional return expected that is the risk premium.This risk premium is used to agree to the risk that is additional”.(Antonio,2013) CAPM is basically estimating the expected return by measuring the risk. This can be found by finding out the Beta of all the 10 companies. The risk free rate ‘RFR’ and the market expected rate of return ‘R(m)’ . The risk free rate is found out by taking the average one year rate of the US treasury markets from the yahoo finance. The Market rate is calculated by dividing the current index with the last year index. After all of the data are figured then put the values to find out the Expected return using CAPM of all the 10 companies that pay dividends. Using the Capital Asset Pricing Model (CAPM). The formula for CAPM is ;
E[Ri] = rf + βi (E[RMkt] – rf)
Conclusion
The constant dividend growth model is an effective way to calcuate the cost of equity. This model when applied properly gives a highly accurate approx value of the future stocks. An example can be taken from the calcuation of all the 10 stocks used in this assignment. The implementation of the constant growth dividend model , the rate of dividend is assumed to be at a constant growth pace . The growth rate should be similar to the market rate of growth. This model is useful not only for the calculation og cost of equity but also in the funds retirement.In contrast to the constant growth model , it is much complex than the variable dividend growth model . This model is more sensible than the constant growth model. The other part was the calcuation of CAPM through SML. This measures the risk return tradeoff . The higher the riskthe higher the return. As can be seen in the case of the 10 stocks used in this assignment. The higher the Beta (Which is a risk indicator) the higher was the return . However , the portfolio should be diverse for investment purposes.
References
Antoniou, C., Doukas, J. A., & Subrahmanyam, A. (2013). Sentiment, Noise Trading, and the CAPM. Working Paper, UCLA, retrieved from http://subra.x10host.com/sentcap9.pdf
Baresa, S., Bogdan, S., & Ivanovic, Z. (2013). Strategy Of Stock Valuation By Fundamental Analysis. UTMS Journal of Economics, 4(1), retrieved from http://www.utms.cc/estudent/index.php?option=com_docman&task=doc_download&gid=88&Itemid=427
